To Yoriko-san, of course, light of my life; but also to all those others who value integrity above commercial gain or personal advantage. Way to go.

Essays in political economics

Twelve Big Lies and the Prairies of Heaven

I. No way you could see it coming

II. Not my job, guv/The dog ate my homework

III. Globalisation. End of story!

IV. Economists understand you

V. Your bank is your buddy

VI. Noblesse oblige

VII. More is enough

VIII. Britain was broken

IX. My grandfather’s axe

Xa. There is no box

Xb. There is a conspiracy

XI. We’re all in this together

XII. All you ever need to know

XIII. We have only ourselves to blame

Acknowledgements

Appendix: a selection of paradigms

A Note on the Author

Go and open the door.

At least

there’ll be

a draught.

Miroslav Holub¹

Twelve Big Lies and the Prairies of Heaven

Morning, said the lemming. How’s tricks?

Morning, replied the reindeer. Not so bad, thank you. There’s some excellent lichen up by Thorsdottirjärvi, and the Aurora Borealis is particularly good this year. Four part harmonies watching the moon, a bit of antler wrestling, that sort of thing. We’re all fine. How about yourself?

"Shortages everywhere. I’ve heard that ‘Lemmings breed beyond the sustainability of their environment’, but what I say, it’s in our nature, innit, so end of story. Anyway, we’ll be all right. Just head west to where the roots are always ripe and there’s no foxes, absolute doddle. 2km an hour on land, swim at 1.5, so if its 1 km to the fjörd and 500 metres to the other side, we’ll be there in 50 minutes flat. Scientific, that is."

What if it’s more than 500 metres across the fjörd? asked the reindeer.

Look, mate, said the lemming, This is science. You want to get up to date. This is economics this is. Can’t go wrong.

***

You may have noticed that the smooth running of global capitalism has been somewhat disrupted recently. There seems to be some debate about whether this is because it’s basically a crap system, or because it needs fine tuning. I don’t want to worry you, but the theories behind it all appear to be either defunct or discredited, or a bit of both, so we may have to do some constructive and original thinking. Actually, this is a bit misleading. Neoclassical economics and so on is only one way of understanding social organisation. There are lots of other ideas about. The difficulty seems to be that a lot of economists don’t want to pay any attention to the other ways, even Cut: /though theirs don’t work, so why do people continue to treat them with awed respect? Mysterious. This is not to suggest that economists aren’t jolly clever. A lot of them are. The problem is that the dominant group have worked out how to use a tin opener, and they’re trying to use it to take the cork out of a bottle of Champagne.

My own role in all this is a little strange. I’ve been interested in economics since 1968 when I was seduced by the glamour of the marginal propensity to consume and the cool elegance of the supply and demand curve. There were a lot of distractions in 1968, however, especially for a 17-year-old, and I duly became distracted. Nevertheless, in August 2011, Pete (who used to be policy director at the Economic and Social Research Council, but please forgive him) and I sent a letter to The Guardian.

X has a field that produces 30 bags of rice a year. Y has water. Z is a strong labourer. If Z digs an irrigation system for X and Y, production will go up to 50 bags of rice a year. Now comes the trick. The whole improvement depends on using the future gain of 20 bags to pay for the work now.

Money is only a promise. The way the world works, the promise can be made by a bank or by a government. Money, which is different from cash, allows us to pull off this trick. Common wealth is created by a reliable promise.

If the benefits are equally shared, X, Y and Z receive five bags a year from the profits, and five go to the bank or government. However, if banks start trading promises, the system becomes unreliable. In part this is because speculative banks can make money from turbulence rather than the investment in extra rice. They make a profit whether the market goes up or down. Instability is to their advantage, and theirs alone.

And what is the justification for this? Traditionally, speculation was said to smooth out the economy, because it was thought that speculators would buy low and sell high. Now the profit comes from the movement itself, not its direction.

So we have two aspects of current economic orthodoxy that are false; first, that government debt is necessarily bad, while the same process undertaken by bankers is good; second, that speculation makes a positive contribution to the common wealth, even though speculators prefer instability. These fallacies have been central in leading us to where we are now.²

A little later I wrote another letter³ – about quantitative easing, discussed in the context of carrots – and a bloke called Michael, who does this sort of thing, suggested I write a book about. It struck me as a good idea because I’ve been thinking about all this for forty years.

In 2005, Raghuram Rajan and I both tried to point out that the likely outcome of current policies was ending up with a blunt tin opener, and booze all over the carpet, but they wouldn’t listen. I’m not surprised they didn’t listen to me – I’m not an economist, and economists are very tribal and territorial. Raghuram, however, was the Chief Economist of the International Monetary Fund, so they might have wondered if he had a point. They didn’t. They told him to shut up. What I’m trying to say is that there are times when you just have to rethink what you’re doing pretty thoroughly. You’ve got to ask if your basic assumptions are out of kilter. France started building the Maginot line in 1930 to help it win the 1914-18 war. It cost 3 billion francs, and was completed in 1939, just in time for the Panzergruppen to go round the end of it through Belgium and reach Paris in time for afternoon coffee and cakes. France was fighting the last war.

I’m going to use the expression paradigm shift for this sort of event; when the ground rules are transformed, the white knight is talking backwards and the castle is charging along the diagonals; and because this is a discussion about an unconventional way of looking at economics, I’d better just explain this crucial term before we go too far. Paradigm is a really useful and, in truth, a very simple idea. It’s Greek in origin, translating roughly as to show side by side. When you show things side by side, you can note the similarities and the differences. An apple and an orange are both roughly round and come with pips included. This allows us to describe a set of objects as round and pipped, or give it a formal name: the Fruitiness Paradigm. That’s all a paradigm is. The descriptor for a set of comparable objects; which is obviously very useful for thinking, because it means we don’t have to start from scratch every time we come across an unfamiliar phenomenon. A grape is round and pipped, so we can make some fair guesses about its fruitiness. Not conclusive, it must be stressed, but indicative and a useful starting point. We all do it all the time, but not necessarily when it comes to political economics.

A typical paradigm in this book could be homeostasis, which refers to systems which tend towards stability. I mention this one, because many neo-classicists have tended to think of the free market as a homeostatic system, which is sadly wrong. Without intervention, markets tend to go through cycles of greed and fear. Even Martin Wolf, a genuine guru from The Financial Times, has acceded to this description, but it seems to belong to Professor Khosla of Stanford University; all of which tends to show that the pretence of market infallibility is well known to be a myth. I can only suppose the myth is sustained, as most myths are, because someone needs a plausible explanation for their disproportionate wealth, power and privileges. So there seems to be a case for a paradigm shift in economics; in the set of beliefs and practices that define someone as an economist. Fritjof Capra’s description of how economists have avoided such a paradigm shift in their profession is close to unbeatable:

…those critical economists who wished to study economic phenomena as they actually existed, embedded within society and the ecosystem, and who therefore dissented from the narrow economic viewpoint, were virtually forced to place themselves outside of economic ‘science’, thus saving the economics fraternity from dealing with the issues their critics raised.⁴

Published 1982, so you can see that this is nothing new. The Scientific Myth Paradigm in operation: a spurious story of scientific objectivity functioning to protect the privileges of economists.

One other type of paradigm before we move on: the rule. Rules apply to events. If an event fits the template for the rule, the rule applies. When passing US immigration, do not try to be witty, for example. Rules tend to be hierarchical. Never wear brown shoes with a blue suit is overruled by never go out naked in a snowstorm. This is sometimes known as lexical ordering. A rule at the top of a hierarchy can be described as an infinity rule. One of these is gravity, the mutual attraction of masses. Another, more pertinent to our current case is that if you borrow money and spend it on wide-screen televisions rather than investing it, you may find the repayments painful. Sounds obvious, but seems to have been missed by the economists guiding the British government. Another infinity rule is Don’t let price and value diverge too widely for too long. Basic errors, and the sort of rule that you might have hoped economists would understand; and hope is a wonderful thing. Daniel Kahneman’s (borrowed) distinction is useful:

Hedgehogs know one big thing and have a theory about the world; they account for particular events within a coherent framework, bristle with impatience towards those who don’t see things their way, and are confident in their forecasts…. For hedgehogs, a failed prediction is almost always off only on timing or very nearly right….Foxes, by contrast, are complex thinkers….. Foxes recognise that reality emerges from the interactions of many different agents and forces, including blind luck, often producing large and unpredictable outcomes.⁵

Economists tend to be hedgehogs. Systematists are foxes, and some of the tools they’ve developed to deal with social complexity will emerge between here and the back cover. Kahneman’s ideas about fast and slow thinking also contribute to this discussion. Fast thinking is about jumping to conclusions, which is efficient if the conclusions are likely to be correct, and the costs of an occasional mistake are acceptable, and if the jump saves much time and effort.⁶ However, because the costs of unwinding the mistakes of economists are about as acceptable as a nuclear war, we’d do better to do some slow thinking as well, even if it’s, like, so unfair, why should I have to strain the brain?

We can do things to help us avoid the crassest stupidities. In Kahneman-speak, System 1 can be programmed by System 2 to mobilize attention when a particular pattern is detected.⁷ When we hear a politician say We’re going to do the right thing, we shouldn’t allow our shrivelled synapses to respond reflexively with a glow of humble gratitude that somebody’s doing our thinking for us. We should treat this as we’d treat a shark alert. Don’t be primed into Pavlovian submission. Try replacing We’re going to do the right thing, with a statement like We’re acting in our own best interests and those of our sponsors, and we want you to go along with it quietly; or We’re panicking, we haven’t got a clue what’s going on, but daren’t admit it. Become sceptical. Broaden your focus. Ask yourself:

(a) why does this manipulative geek think it necessary to deny that their intentions are malevolent, even before anyone’s suggested it? and

(b) what evidence and other views are there on the subject, and which are the more realistic?

Decide if you need to think carefully about the pup you’re being sold.

And the last of Kahneman for now: he reports on research that suggests that if we’re primed to think of money, we become more individualistic and less socially responsible. So when you hear a politician say We’ve had to make hard decisions about the economy, so we’re cutting benefits to the disabled, remember that your instant response is not a reasoned judgement; and I hope you never have to learn to live with a serious disability. So if those are some of the lies, what’s all this about the Prairies of Heaven? It’s partly a joke, but a serious joke. Maybe we don’t expect to create heaven on earth, but, as sure as eggs is eggs, we do hope to make progress in the right direction. It would clearly help, then, if (a) we could agree what the right direction is and (b) how to head in it. In relation to (a): every politician that ever breathed, including Caligula, claims that they have justice on their side. Unfortunately, justice appears to have more sides than a disco mirror ball. My perceptions of justice will become apparent as we go on, but it’s probably best if I make a couple of things clear from the start.

When I hear someone talking about how humans are genetically programmed to compete and the world is a jungle, I feel tempted to cut their shoe-laces, particularly if they try to portray any other vision as naïve utopianism. It’s incredible how Social Darwinists are able to avoid noticing the co-operative elements of successful societies. Social Darwinism conforms to the Scientific Myth Paradigm: it’s a bucketful of hooey designed to justify greed through a simplistic and spurious rationalisation of selfishness. Adam Smith accidentally lent strength to this unpleasant philosophy by suggesting that the market can replace moral action. For reasons that will become apparent, this is simply nonsense, and not at all what Smith intended. It’s popular nonsense, because it excuses all sorts of behaviour on the grounds that our only obligations are to respect private property and the free functioning of market transactions; a convenient myth for the privileged and corrupt. The market, as well as being a superb way of increasing productivity, has inherent weaknesses that lead to a wide variety of repetitive failures. If we wish to say we have justice on our side, we cannot, therefore, use the market to supplant our moral obligations. Within a wide range of matters, we can, for all practical purposes, choose how we behave, so it’s no use saying it was your genes that made you do it, or that your evil deeds were purified in the crucible of the market.

So there’s my manifesto. Economics reformed as a discipline. The market recognised as useful but dangerous. The aims of social organisation to become justice and welfare, rather than mindless greed. That still leaves us with the nature of justice to contemplate, and how to do it. I’m not sure how far down the road we’ll go in this discussion, but at least it’s a starting point. And, of course, I haven’t got a clue whether there’s the will to do what needs to be done. On a sunny morning, when the bread is rising, the beer fermenting, and Yoriko has promised udon noodles for supper, I believe that anything is possible. Yes, we can take apart this sorry state of things and remould it closer to the heart’s desire. On other days, I think of the boiling frog. It has been claimed that if you sit a frog in a pan of water and turn the heat up slowly, the frog will boil to death. It just sits there, paralysed by habit, and hopes that things will get better. So it is with us. We seem to have failed to grasp the principle that if you keep doing the same old things, you’ll keep getting the same old same old. Even worse, if there has been a fundamental shift in the way things are, doing the same old things can be fatal; which is why I will be arguing that as well as the structural faults described by Fritjof Capra, changes in technology and in the global economic system mean that economists are fervently analysing something that passed into history circa 1999, or even earlier. Production need no longer be the principal concern of economics. It’s distribution that we need to get sorted out.

In a way, that’s about all one needs as an explanation of the crisis in the global economy. More technically, one might say that neoclassical economic theory recommended globalisation, but can’t cope with the consequences, like one of those zany friends who says Let’s all go and have a pizza!, only it turns out they haven’t got any money. Really that simple; but do not despair. When I say that there is no widely accepted alternative, it would be fairer to say that there are a number of brilliant economists, including several Nobel prize-winners, who are well informed about psychology, moral philosophy, comparative religion, game theory, anthropology, systems theory, the arts, and who have a broad consensus that is not dissimilar to my own. Unfortunately, because they are well informed about psychology, moral philosophy, and so on, they seem to be treated with deep suspicion by the political establishments of the world.

In brief, I would say that the consensus is that we don’t have to live like this, with life being pretty good for a lot of people, but pretty terrible for many more. We can select an alternative. The basics are described by Confucius, the Shandong shepherd, Minister of Justice, and itinerant philosopher; and archy, the new york cockroach and vers libre poet, who always used lower case because he couldn’t operate the shift key.

From Confucius, the values we should rationally seek to develop in ourselves, within our families, and within our communities are these:

- Compassion

- Duty

- Righteousness

- Knowledge

- Trust

And from archy the cockroach:

i have noticed that when chickens

quit quarrelling over their food

they quite often find out that there is enough for all of them

i wonder if it might not be

the same with the human race⁸

The First Big Lie: No way you could see it coming

- Causality, greed and accountability

The first draft of this book was completed in January 2012. A lot of what I wrote about has since emerged from the underground and become something akin to accepted wisdom. No matter. The aim was never just to point out the current fallacies, but to suggest that they arise from ways of thinking and institutional practices that are mistaken, dominant and entrenched. It’s as though we were getting lost every time we asked a neighbour for directions, but just kept asking the same neighbour. Conventional economics needs to change its role, to become part of a network of disciplines, not to perceive itself as the one great way to organise society; then the prairies of heaven might begin to emerge from the hazy mystery of the future.

A lot of people invested their trust in a system that now seems to have been seriously flawed, and want to know who to blame and what to do about it. This is a personal response. I hope that it will lead to a lot of constructive discussions, because there seems to be a realisation that economic theory is somehow at fault. Too right. Time for a radical overhaul. No tinkering at the margins. Rethink.

So what’s wrong with the system, and is there anything to be done about it? My answer to the first question takes up a lot of this book. Along the way, quite a few positive suggestions will emerge, some of which you may find outrageous. However, what I most hope is that from this process a broader and more vigorous understanding of economic issues may emerge. If you want to, you can think of me as a proper grown up economic agent: a fully informed rational person seeking to maximise his utility; but if that’s all I am, let me curl up sere and withered, and shuffle off this mortal coil.

The first big lie is that there was no way you could see it coming. This is a straightforward issue of competence and accountability. It was foreseeable, and there should be much more humility around than I’ve noticed so far. My mum used to say Credit where credit is due in a Quakerly way to encourage us to acknowledge achievement. Seek that of God in everyone. Look for the best in people. Some swans are black, and some bond traders are decent humble honest men.

At the same time, I like the American Quakerly idea of speaking truth to power. Someone’s got to, and it’s certainly powerful people who should take the rap for the chaos we experienced in 2007/8, and the pain we’ve suffered thereafter. Events on such a scale are not caused by the bankruptcy of a family butcher in North Dakota, even if that could have been the event that triggered the whole calamity. Whatever local events led to the disintegration of the system, the origins of the problem lay in the fault-lines and fractures in the whole edifice, so let’s cry Havoc! and let slip the dogs of war. Who was responsible? Should they have seen it coming? My nominees, with rather uncharitable annotations, for those most responsible for this most recent in a series of system crashes are:

- Journalists, for levels of pomposity and self-importance matched only by their ignorance and bigotry

- Economists, for collective and persistent failure to recognise the limitations of their craft, and/or for perverting it for personal gain

Well, that will have made me popular. It’s also unfair to quite a lot of people in each category, but I don’t seem to feel very apologetic yet. Perhaps a hit squad from the Society of Friends will come round and forgive me in a very pointed way, and then I’ll feel bad. Before that humiliation, let’s see if the accusations can be justified. Which paradigm do the circumstances call for? Let’s whip out Aristotle’s Causal Paradigm, a trusted favourite, which goes like this.

What was:

(a) the subject matter (or material cause)?

Something had to be there to be changed; something was the heart of the matter. In this case, the material cause was the complex web of societal relations and social, communal and personal experience, partially mediated by commercial transactions. Society, for short.

(b) What was the form taken by the subject matter?

The dominant ideology has increasingly taught people to think that you can leave most things to market forces and achieve an optimal outcome. Due to the neglect of social and emotional values, the organic structure of society has increasingly been replaced by market relationships and cash transactions. Profit and consumption are deemed to be both inherently good and psychologically fulfilling. Individualistic materialism is the way to go.

This view was driven by …

(c) … the intentions of those who stirred the mix.

During the good years, a general sense of mindless entitlement flourished in the materialist environment, encouraged by corporate capitalism, which to remain superficially healthy depends on reckless consumption. This is easily exploited, because it’s apparently not hard to persuade people to go into debt to pay you for the tat being produced. There have been, therefore, great opportunities for the unscrupulous to promote an unsustainable orgy of consumption. Some people did well out of this.

So who were…

(d) … the principal agents of change.

I’ll give you a clue. It was bankers and their economic acolytes. However, they were not alone, so how do we share out the credit for the current debacle? Politicians should get the credit for the shape a society takes. That is what they are for. That is what leadership is about. Thatcher, Reagan, Blair, Brown, and sundry others, and now, sweet heaven protect us, perpetuated by Cameron and Osborne, Gove and Lansley in this country, and others elsewhere. It is not one political party that takes all the blame. It’s the whole political process, which conforms to the Dodgy Guru paradigm: whatever the original purpose of an institution, it can be reduced to a mechanism that achieves little apart from delivering privileges and status to its leaders.

(Added note: at one time in my life I associated this paradigm with several institutions from various regions of Ireland. They seemed to need enemies to justify the behaviour of their leaders, rather than leaders to protect the members from enemies. However, BBC, 6 September 2012: the Royal Black Institution in Belfast apologised to St Patrick’s Church for any offence caused by their choice of music outside the church. The Institution said its anger was not directed at the Catholic church but at the Parades Commission. Fr Michael Sheehan said: I welcome this positive development and the sincere Christian spirit behind it. Credit the Royal Blacks. There’s always hope.)

If there were more difference between the parties, the electorate might be more to blame. As it is, aspirants to power in a democracy seek to appeal to the mainstream. Normal distribution means that, on most dimensions, there’ll be a majority to be placated somewhere in the middle; on income, for example, between £20K and £150K a year.

No elected politician dare offend this middle of the road inertial mass, which likes things pretty much the way they are; who certainly don’t want to be told that they have no unequivocal right to borrow and spend and become extraordinarily wealthy on the back of a house price bubble. Remember, our leaders just want to be elected. It doesn’t have to be for the right reasons. Consequently, the candidates stay schtum, even if they can see what’s happening, and it would be harsh to blame the punters for accepting the unanimous deceit of their political representatives.

Supporting this farrago are The Media, who get the credit for being the Meeja; that is, presenting themselves as reliable sources of This is where it’s at or Serious Insight depending on who owns their souls, while having all the percipience and principle of a lobotomised Caliban; with honourable exceptions, it must be admitted. Nevertheless it seems to me no coincidence that in the trust tables journalists always struggle with politicians and business leaders to claim the title of the least esteemed professionals in our society. So the Meeja should be given credit for their contribution to the implosion, because they habitually mislead the punters by commission and omission, and because they are collectively committed to truth and understanding like Don Juan was committed to monogamy. To simplify, our society has been trained by politicians and the media to believe in the sustainability of limitless consumption, in the interests of the few who are creaming it off the top.

We could also blame the corporate capitalists, but, perhaps strangely, I’m sometimes hesitant about this. They often seem to work within the rules, even if only for the sake of appearances. For example, the fact that the availability of burgers and obesity are closely correlated is probably not directly causal. Nevertheless, according to Harvard University, for the first time in human history, the world has more overweight than underweight people, and globalization is a major reason for this: It has brought McDonald’s franchises to Mumbai and SUVs to Shanghai, digital TVs to Dar es Salaam and Nestle’s supermarket barges to the Amazon River delta.⁹ McDonald’s doesn’t force people to become obese. Indeed, you can see online that a single cheesburger and small chips and Coke Happy Meal offers a gal 32% of her daily kcals, 34% of her fats, and 40% of her salt.¹⁰ One might live on three Happy Meals a day. The information is there. Freedom of choice. McDonald’s has a duty to its shareholders, and, therefore, when nutritional degradation takes root, McDonald’s has a duty to exploit it. Thus, despite some very dodgy behaviour on issues like directors’ bonuses and tax avoidance, corporations surprisingly often work within the rules. It’s up to democracy to make sure that the rules produce the outcomes we want, and enforce them; a set of outcomes which, I assume, does not include teenagers who are simultaneously obese and malnourished. Of course, where corporations seek to get the rules bent, or lie, or bribe, that’s a different matter.

Of course, where corporations seek to get the rules bent, or lie, or bribe, that’s a different matter. Starbucks and Amazon, for example, seem to be fulfilling their tax obligations in the UK while causing a fair amount of outrage to those who perceive those obligations as being disproportionately small. If they’re within the law, they’re within the law. Indeed, they have an obligation to be tax efficient in the interests of their shareholders. If they’re taking advantage of predatory tax regimes, it looks as though their conduct is impeccable, but that the rules are seriously deranged. If globalisation tends to concentrate commerce into the hands of effective monopolies which can switch the money round so they only pay taxes where there are none, you can’t blame corporations for being advocates of what, for the general welfare, may be a grossly ill-devised global economic system. However, just now we’re looking for those to whom the principal credit must go for the widespread misery, but you have to ask if the rules are right. When globalisation concentrates commerce into the hands of effective monopolies which can switch the money round so they only pay taxes where there are none, then the rules are wrong. So corporations are eager beneficiaries of and advocates for a grossly ill-devised global economic system, but just now we’re looking for those to whom the principal credit must go for the widespread misery; and who else, in the end, could claim the Oscar but the financial services industry, and the economists who so tirelessly promoted its interests? They can proudly claim to be the principal agents of the recent fiascos, even though they seem bashful about doing so.

And how did they do it? Pass the parcel. Here’s how you play. If you want to lend more money than you have, there are rules about what you can do. At the time of the crisis, the set of rules known as Basel II was in operation. This international agreement set the ratio between what hard cash you had and how much you lent. The hardness of the cash was graded. Say you’ve got £10 in actual cash: that counts as £10. A $10 US Government bond is pretty good, say 75%: that counts as $7.50 which is £5. A £10 block of shares in a Congolese mine that you’ve never actually seen, say 20%, so that counts as £2. Total reserves: 10 + 5 + 2 = £17. Say a reserves-to-lending ratio of 1:3, and you can lend £51. However, let’s imagine that some of your capital reserves take the form of gift-wrapped parcels that you are assured are full of solid value, but you haven’t opened. What do these count for?

Basel II put its faith in ratings agencies, even though the rating agencies had put their faith in Enron, for example, so the degree of their omniscience has to be in doubt. Enron is a good example. It was, you may recall, an energy company that found it could expand at a tremendous rate by hiding debts in shell companies, so they didn’t appear on the main balance sheets. Basic technique for a scam. Lie about your assets or your profits to leverage more funds. The company may be hollow, but you can keep on borrowing at good rates. Bet on the right horses and you’re home and dry. At worst, as an individual, you have a fair chance of walking away with a brief case stuffed with thousand dollar bills. All depends on your credit rating. Enron was adored by ratings agencies.

A confidence trick, then, with the confidence provided by Moody’s, Fitch, and Standard and Poor. A variation on the Ponzi scam, so well described by Charles Dickens¹¹ about 30 years before Carlo Ponzi was born. Nothing new, then. No reason not to be on the lookout. And if, as a banker, you had Enron shares in your portfolio, what would they be worth? 100% of face value? 50%? 0%? Ask the rating agencies, again, and then crank up your lending by a large multiple of your holding. This is leverage, and leverage makes you a Master of the Universe.

Enron blew up in 2001. Basel II came into force in 2004, giving the ratings agencies further authority to determine how risk was to be estimated. Among the forms of hard (or not so hard cash) available were various gift wrapped packages backed up by mortgages. Many of these were smiled on by the ratings agencies, so that they could go straight into the basement, earn you an annual return, and rack up your leverage all at the same time. Buy a £100K parcel of mortgages. Score it at 100%, and with the 1:3 rule, you’ve got another £300K you can use to play the market. You could even lend it in the form of mortgages, and then wrap up those mortgages in a parcel, and round and round it goes. Call it securitisation, and it even sounds like a risk-free, sober investment. But what’s in the parcel? Ah, there’s the rub. Old newspapers; not literally, but not worth much more. This is where the sub-prime market comes into the equation. Sub-prime is wonderful euphemism for reliable as a cardboard razor.

The sub-prime market provided immediate cash incentives to mortgage advisers to sell their products to bad risk clients on the back of an over-priced and rising housing market. What, you cry in horror, about those poor bankers who were trusting the sales force to undertake due diligence before lending the banks money? Did they hell. They weren’t going to hold onto the dodgy mortgages. They were going to package them up and flog them, gift wrapped, to suckers like Adam Applegarth at Northern Rock. There were a lot of different forms of gift wrapping. Consider this portent one:

If you bundle up a load of slightly risky securities together, you reduce the risk because they’re not all going to fail at once.

It looks quite convincing at first sight. A 25% risk looks less frightening if it’s in a parcel with an 80% risk and a 100% dead cert. However, consider it like this. If you have two hyperactive children and one who’s normally quite calm, and you put them in a room together, are you reducing the risk of them all going off? Or are you increasing the risk of setting off the calm one? It’s a familiar question in science. Are these events linked? If so, does A trigger B? Or does B trigger A? Is there another factor X that can trigger both A and B? In the case of the gift wrapped mortgage parcels, there was clearly an X: the fact that the mortgages were dodgy on both sides of the deal. The holder of the mortgage, who had probably been enticed into home ownership by the promise of rising prices, finds they can’t keep up the struggle to keep up the payments. Not particularly their fault. As the process had gone on, the potential home owners were getting